Microsoft Financial Analyst Briefing 2017
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Microsoft Financial Analyst Briefing 2017
Financial Analyst Briefing
Amy Hood
May 10, 2017
ANNOUNCER: Please welcome Amy Hood, Executive Vice President and Chief Financial Officer.
AMY HOOD: Hello. I didn't have Phil just come talk about gaming because he said something nice. It's actually, and I'll get a chance to talk about it, we sometimes pick topics for this audience that we feel like you may not understand the structural importance of enough and why they're so important to us, and gaming is one of those. So I hope you got a feeling of how critical we think it is of an asset to the future.
I'm going to quickly sort of talk more financially, not surprising, about some of the trends we just talked about. Our focus over the past few years have come from the ambitions that we talk about, ambitions for us also happen to be reporting segments to you. What I would say, though, is really the acceleration, however, doesn't come from their individuality, it comes from their overlap.
And so I think what you're going to hear me and you've heard Satya talk about it is really a pivot about how they tend to work together to make a more important flywheel that builds on itself. If you think about people, he sort of used two frames, right, people and organizations, one of the fundamental constructs of that is selling per user, and there are lots of things we sell per user.
Let me walk quickly through the consumer ideas that we sell in that value.
The first one is really Windows and Windows in its broadest sense. The goal for us with Windows has been quite simple over the past few years: to grow users and grow fans. Windows 10 has higher satisfaction than any previous version we've had of Windows. We're incredibly proud of that in the journey we've been on. The progress you see in the gray line of modernizing that install base, particularly in consumer, is fundamental to creating opportunities for our services to extend beyond Windows. Things that you might think of as extending beyond Windows particular to the OS would clearly be things like the store, search, and search and its relationship to the browser. And hence all the investments we've made in Edge and much of the progress that we've made in Edge you see in our search growth.
What I would say here is I think about really Surface as a fundamental part of what we do to move Windows forward. Surface has stood for creating new categories, the two-in-one category, Studio was an all-in-one that's beautiful, that's optimized for ink and creation, or whether it's the new laptop from last week -- we've been announcing things at such a pace I'm losing time horizons, that one was last week -- and what it says about the future of an OS. And so when you think about our hardware, think about it as naturally showing and showcasing the innovation we're making with our software.
Then you think about what's the next thing we sell per user, right, a natural extension? The first and the one that people think about the most is one of the two cores that we have in terms, of, especially on the consumer side, consumer vision, it's of course productivity. When we think about what we do, you think about productivity.
And when we were here two years ago we were really talking about the transition to the new subscription model and when would we get through it and would we get through it, and the answer is we're through it and we feel really proud, actually, of getting to that 26.2 million person subscriber base. When you think about that, that's another networked asset that can take advantage of the Office Graph and adds value to the Office Graph.
And I think at this point even when you think about the growth curve we're thinking about here on consumer, you have to think this is happening even with overall consumer PCs in decline. So this really means attach is doing quite well. We're continuing to see subscribers. We're seeing good renewal rates, and we actually feel really good about the value we've added to this business and, of course, it's relevance across multiple end points even beyond Windows itself.
I mean, let's talk about the next fundamental part of productivity, which is really the investment we've made in LinkedIn on the member side. Think about as LinkedIn having two fundamentally different things: It has member value and then it has business solutions value, and we'll separate those for this purpose.
This is really saying we have 500 million members. We announced that last Monday as well. But really when you think about the health and vibrancy of any network, it's not the total number, it's whether or not the sessions and engagement is growing. What you can see here is that sessions are actually outgrowing membership. Engagement is getting better. We're adding value. The team is incredibly focused on adding value to the member, and while member growth is important it's really about their engagement and what we can add to them. And if you think about a slide Satya showed where he shows the Office 365 Graph, sort of the LinkedIn data node, as well as -- you combine those in your mind, you can see the potential to even add more network and valued assets to the two end points I've just covered.
The final one, we kind of have two cores if you think about it, what we're uniquely good at doing when it comes to the things Satya talked about, you have to rate things by your competencies. The second one in competency is bringing these networked active user bases together in gaming. When you look at this graph, think about the top as being our total growth we kind of expect overall in the Xbox Now. What's interesting, really, is the curve and the acceleration we've had. This is two years ago, we had nothing beyond the console, nothing. We're already at 25 percent of our Xbox user base. We'll be using Xbox and engagement with it beyond the console, all those other endpoints that Phil talked about.
And, frankly, with the extensions of some of the thoughts we have on the importance of mixed reality to this business, I think that number obviously we think can go to 40. And I think the real question is when does it get to the perfect overlap where no one will only play with a single endpoint ultimately when you think about the extension value and the networked assets. But you can really see our confidence in our ability to land that broader strategy.
And some people know, this is already a $110 billion market. Console games and the services that relate to them are growing really double digits. So when you think about us, we've got a multibillion dollar business that's profitable and growing profitably. And the foundation that lays to add on the new business models, whether, as Phil mentioned, ads, subscriptions, selling gaming in that direction, whether it's the ability to think about RPU editions through low value watchers, whether it's the video models that we have through assets like Beam, I think it really opens up the possibilities of that market far beyond the $100 billion that we're already able to compete very effectively in.
Now let me pivot to more of the model of the org, adding value to organizations. And of course we're going to right back to Windows and per-user value. It all starts at selling user value, and then we'll extend that to departments and ultimately to app development
But the first one, which is what Satya talked about as the secure, productive enterprise, in our world what a secure, productive enterprise is is generally one, think of it as running Windows 10 in a modern state, taking advantage of security and management, maybe using our unique hardware assets as an instantiation of what's possible, for example, a Surface Hub, a large screen device, right, as the natural and only ability for us to create a category that creates a more productive workplace.
You could think about it, of course, as Office, right, Office 365, that's a secure productive enterprise asset. Think about it as our most modern tools being used and deployed together to have the most secure and manageable and consistent environment, and we shortcut that to call it the secure productive enterprise. The first component obviously is Windows.
When you think about Windows it combines two things, because I think of them as similar, right. It's sort of what's our OEM pro business, right, selling commercial devices and selling our own devices into commercial businesses, whether they want to buy Surface for a certain group of users and not for the entirety, whether it works better for mobile versus not, it's really about building, again, showcase devices that extend the building.
We've done a very good job of seeing pull on Windows 10. We talked about that. We've seen growth in the market. We continue to see very good endpoint demand for Windows 10, and I think the OEMs have seen it, too, in terms of their confidence in building machines in advance of what we continue to feel is a pretty strong global, actually, environment on the commercial side.
And on top of that what I've also added is we added a new KPI this year, and I'm not sure everybody still understands what it is. So I thought I would take an opportunity and explain a bit more of it. It's Windows commercial products and cloud services revenue. What that really means is the part of our Windows value sold into the enterprise that looks far more annuity-like. It's sold more traditionally, and our EA has the same concept of adding multi-year value. It tends to give you certain upgrade rights, but the more important things that have resonated far more with customers have been things like the advanced threat detection tools that we've launched. We shortcut it and customers often refer to it as ATP.
That value is what we're seeing a big transition here from what used to be even a non-annuity business for us to a consistent double-digit annuity grower, when people see the value that we put into some of our security and management products. It's, I would argue, a very compelling price point, compared to many of the vendors that we compete with often in this space.
Next, we're back to Office. I think two years ago I showed this exact scrapbook. And we said this is what we felt about both growing our install base and moving the install base. It's just an orient you right, Office 365 is at the top, and I used the shades of blue, it's sort of a blue-themed company. So that's the cloud component of the install base.
The annuity component is next, and this non-annuity base is at the bottom, right. And so when you think about where we are, we're actually tracking ahead of where we said and, frankly, if you were to look at this graph this is at 50 percent currently of our current install base. So I think we feel very good about the transition, about the pace of the transition, about the deployment numbers, that's the 100 million we referred to publicly and Satya often references in terms of moving our customers forward to this modern, secure, productive enterprise.
And so I think when I look out I feel pretty confident in the trajectory we're laying out here. But I also want you to see the confidence in continuing to grow the install base. Install base growth for us is in many things like I think you just saw Satya talk about, frontline worker expansion continuing to make progress there. Now this doesn't actually talk about room for RPU improvement. That's not what this graph is about. This graph is about growing the install base and moving the install base forward.
When you start to think about our ability to deliver the LTV, we showed an LTV chart also, and these all kind of blend together some days, the same LTV chart by moving certain customer types. What I would say today is not only am I more confident in delivering on every LTV scenario I showed you two years ago, I think I may be increasingly confident as we start to see the results and early value props out of E5. It takes a while for them to land, just the way it does in any enterprise cycle. But I really do feel our opportunity for RPU expansion, especially in the customers that we've already moved to E3, to confidently move them to E5 gives me even more confidence that the LTV numbers can continue to even get better than we showed two years ago.
I also talked about Exchange. Exchange you'll notice, I think this is one where many people wonder could you still grow the install base, again, just like they wondered about Office. Not only have we delivered on the install base growth, you've seen it. We're a several digit install base grower. I do think we continue to have opportunities, as well, in Exchange, for many of the same scenarios we talked about.
I do think we are on track to doing a little better maybe than we thought we'd be. We've actually accelerated the growth in the past year or so. I still think even while we continue to add install base, we can continue to still have that cloud transition up into the 70s, which I feel quite good about.
I will call out in both these charts the non-annuity component continues to exist, right. I mean there continues to be a base there that slowly comes down over time. But I do want to realize that it won't go ‑‑ it's not just sort of it goes away on any given day. This is a bit about the life of any product has a bit of a longer tail.
Now I'm going to talk and move from what people think of as that Office per-seat concept to a slightly different per-seat concept. Windows and Office, you think about them as covering sort of everybody, right. In most entities it's a broad breadth product. You tend to move organizations in lumps, right, with broad customer agreements, we happen to call enterprise agreements.
Quite differently is our Dynamics investment, plus the LinkedIn business that's more of a business solutions sale, selling value to HR professionals or to sales professionals. When you think about this chart, first of all we have a Dynamics business. It's roughly $2 billion, growing consistently double digits. But what's really changed is the modern actually product roadmap that we've delivered on. We now should this call that thing, for consistency, Dynamics 365. It's not just the CRM suite tools, it's all the way through including our ERP solutions are now cloud-based. We sell not in large suites, but more in a focused role-based model.
The value is quite different. We feel very good about our value prop. When you think about these charts, when we add in the opportunity we have with LinkedIn and the announcements that we made two weeks ago right before earnings on some of the integrations you'll see, such as Dynamics 365 for Sales, plus LinkedIn Sales Navigator. The second product we set in motion that would be ready for July would be Dynamics 365 for Talent, plus the LinkedIn HR solution. We'll both be able to sell those to end customers. And so you really think about that as adding I think some accelerant to our ability to grow on both sides.
And this should be over a $5 billion business for us in FY '18. That is a very meaningful foot in the business solutions space. And I think our ambition here is quite high and our expectations for growth are also high. I think we have a unique worldview, and you also see the distinction here is in that combination plus the acceleration, you wind up with about a 70 percent cloud business when you look out a year. It will already be a pretty modern install base.
Now let's go to server and tools as I guess people refer to as ancient history. But I think that's what I often still call it. It dates me. What I would say here is I think the big question people have always is was this going to be transaction business, where you replaced a consumptive workload that we used to sell as a server with Azure revenue. I feel like with the CAGR that we've felt like we've delivered in this business, which in a constant currency basis I feel is durable I think is the word I used on the earnings call, durable, double-digit revenue growth. I think we have shown really the power of having an intelligent cloud with an intelligent edge.
Think about that as hybrid shown as revenue growth. And I feel very good, especially if, and I would urge you to spend a little more time seeing that two-hour Build keynote-ish from this morning, and watching all the value that got landed, whether it was Azure Stack, whether it was Cosmos DB, or frankly, whether it was some of the SQL and database value you saw, I think we feel very good about the continuation of value of the intelligent edge particularly in this business.
Generally we have talked in our business about a run rate. And I love run rates, but I thought because we talk about gross margins we would show the revenue in quarter, this is actual non-run rate revenue. We will have as we look at the guidance that we gave really close to a $15 billion commercial cloud business this year, at roughly a 50 percent gross margin.
We feel like we've made a ton of progress here, incredibly proud of this business, and I think in many ways when you look at these growth curves this is growing 55 percent this year on a very big and strong base. And so I think when you try to get a sense of our aspirations here, I think you can get a sense.
I would also say about our $20 billion run rate target, you know, it's still our target. We'll still get there in FY '18. And we'll still report on it so you know when we get there. That's what I call accountability. But I do think when you get to this size and you start getting as close as we are, I think it's easier just to show the flat-out revenue numbers. And so there you go for comparability as I know you all try to build your models into summing columns. (Laughter.) I think you try to make them sum, but some days.
Let me talk about a little bit about then why all these metrics that we call KPIs? Why do we pick them? Frankly, what you just saw me do in all that presentation was explain why each of these matter. In your mind, if you can almost think about which ones relate to each other in a per-user motion, they don't correspond to our reporting segments. Many of our motions are fundamentally connected to each other, but not connected within a segment. And so the appreciation of what really moves together.
Windows commercial deployment absolutely can move the needle on our Office 365 commercial MAU. The motion of updating your enterprise to a modern, secure, productive enterprise absolutely will accelerate users’ adoption of Office 365. The absolute same is true of the logic we've built with Dynamics 365 and its relationship to Office or its relationship to Azure. All the Dynamics components are built on Azure, use Azure, the extensions of them encourage ISVs to build through Azure, all of those land, but they land in productivity and intelligent cloud. And so the interrelationship we see of these assets I just felt like was more appreciated if you kind of use a frame of saying what do I sell per user, the secure, productive enterprise, how does that relate to our ability to sell more compute, which you all think of as Azure, or more value add. And so these are why we picked them, but I wouldn't say they move individually. They move in relationship.
Our commercial cloud we talk about as one thing, because frankly our motions of selling are one thing. And when I think about the results we've seen in Azure this year, which I'm incredibly proud of, the investments we've made in the sales engines, think about the stories, they're not really stories because they're true, that Judson just said. The customer examples he gave were never about this is an Azure example, this is an Office example, this is a Dynamics example, and, oh, by the way, here's a HoloLens example. They were fundamentally about the interconnectivity of these assets.
And so I hope if you take away anything from today other than trying to figure out the scale of my graph that -- (laughter) -- there's like tools that I think do that for you, so I'm just going to rely on you to go for it. But what I would say is, what I hope is that you understand the scale we're operating at, our ability to continue to improve our margin structure, and the interrelatedness of both our motions in the field and our sales and maturity that we've grown as well as how that shows itself in our results.
Now I'm going to move to what everybody has been waiting for, which is accounting, because if you're not excited about accounting you're going to be after this. This is what you really waited for. The shape of FY '18, revenue growth obviously will be continued to be focused on and depend upon our commercial cloud strength. It's been true for years, continues to be true again next year.
I will remind you as you are building out your models we still have a headwind on a phone comparability issue for H1. After H1 it goes away. We do expect the company gross margin to decline a little bit, that is from commercial cloud but also we have a full year of LinkedIn amort in the model, and so I would encourage you to include that as you think through the structure. We have hardware launches, one of which Phil referenced, which is “Project Scorpio,” that tends to have and can have an impact on company gross margins in a given year even if the structural improvement in every segment increases.
Commercial cloud gross margin should continue to improve, I show you the graph, even as Azure mix increases, which it will. Operating expenses, we'll have a full year of LinkedIn. We will continue to invest in LinkedIn and our commercial cloud to support and because of the customer engagement we see as well as the opportunity we see to deliver and continue to deliver top-line revenue results. FX, hard to predict, but based on rates now we'll have a bit of a headwind in H1. Our revenue, really no impact on the OPEX side.
Continue to remain confident in our LinkedIn impact for '17 and '18. And capital expenditure year-over-year growth should be similar to '17. This is why we plan quarter-to-quarter. You saw the impact. This quarter we were light. It could be heavy. We said it can move out. This one this early it's similar. We'll continue to evolve and see what we need to do.
Now accounting, two new standards get adopted this summer, right, when we start FY '18. First and most importantly, neither of them impact free cash flow, neither, right. Now the leasing standard I'll do first. It's the far column. It only impacts the balance sheet, okay.
The revenue standard, which I think is the far more meaningful one as you try to work through the impact on the P&L, we didn't disclose in our Q3 10Q, this is for a year ago, which is the only one we completed to give you the estimate for, about $6 billion of revenue impact. That $6 billion is primarily, right, the Windows 10 deferral that we adjust for non-GAAP already. So that adjustment would then go away.
There is some impact to both the Productivity and Business Process segment as well as Intelligent Cloud, because of this component here. If you sell a new license on-prem in a multi-year agreement, I'm narrowing the scope for you a little bit, right. So if you sell a new on-prem, multi-year agreement and you have a new license in it, so it's got to be not just ‑‑ not a renewal, renewal there's no impact, a new license, you have to account for the license component up front. That will have some impact.
It particularly has impact quarter-to-quarter, because it depends on the timing of when your EAs come up and get signed. And it's not consistent through the year. So what it will do is introduce some quarterly variability, but over the course of the year it's a much smaller impact, right, because it would net much smaller than any individual quarter.
Now let's talk about how we're going to work you through that transition, just so everybody can plan. In July we will report obviously Q4 in the old way, because it's still the prior year, right. We will file our 10K under the old standards, right. We will give guidance using the old standard so that you can kind of understand comparability-wise what Q1 looks like.
Then August, in August we will provide two years quarterly of restatements. So you'll have all of '16 and all of '17 to start to see the impact. We will also convert the guidance we gave to the new form. So you can start to see, you'll then have ‑‑ that will be eight quarters plus you'll get the guidance converted and you can start to see trend lines.
Then in October we will only report in the new way. For some of you who have been covering the company for a while this will look familiar to how we rolled out some of the reporting segment changes, because familiarity tends to work a little bit easier, it makes Q4 cleaner and the guide cleaner and then any reconciliations cleaner. So this is just so you can prep as you think about July and not trying to do all sorts of conversions in a very, very busy time for all of you, too.
Finally, thank you. I've been in this job four years. It feels like just today. But it's been really an honor to represent you all. I think of it that way. I represent your concerns. I represent your insights, both inside the company as well as to our board, and I think I've learned a lot from you, from all your pushing. But I also think and I'm really proud of this company for delivering what it said it would deliver to you a couple of years ago. And I feel great about that and I thank you all for your consistency and support.
And so with that, what I'm going to do is Satya is going to come join me on stage for Q&A. Judson and Phil will be sitting out here in case you have specific questions for them, as well. So let's flip it over.
END
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